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HSAs: When your health insurance becomes a retirement account

A few weeks ago, we received an email from a reader who had some questions about his health savings account. The email raised two interesting questions: Are these tax-favored insurance products becoming retirement accounts, and, to quote the email, “does anybody regulate these clowns”?

Theoretically, HSAs are meant to be a way for you to use before-tax money to pay for your healthcare costs when you have a high-deductible plan (meaning your deductible is at least $1,200 a year for an individual or $2,400 for a family before your insurance benefits kick in). But they have morphed into something more than that, thanks to their triple tax advantage:

Your account contributions are pre-tax or tax-deductible.

All earnings, interest, and, yes, investment returns are tax-free.

Any withdrawals for qualified medical expenses are tax-free. Plus, once you reach age 65, all nonmedical withdrawals are taxed at your current tax rate, just like a traditional IRA. (If you withdraw money for nonmedical expenses before you’re 65, then there’s a 20% penalty.)

Investment returns? Indeed. It turns out that HSAs aren’t limited to cash. You certainly can put your money (restricted to $3,250 for an individual or $6,450 per family per year, plus an extra $1,000 a year if you are over 55) into an FDIC-insured savings account. State Farm offers such a product through State Farm Bank. But many companies offer a richly varied menu to suit any risk appetite: a company called Health Savings Administrators, for instance, gives you a list of of no fewer than 22 Vanguard funds to choose from, including funds devoted to small-cap stocks and “strategic equity”.

Wells Fargo offers both types of accounts. When you open an HSA at Wells Fargo, you put your money in an FDIC-insured deposit account that pays a tiny bit of interest annually. Once you have $2,000 in that deposit account, you then have the option to start putting money in a separate, non-insured HSA investment account, with various mutual fund options.

For anybody with high-deductible insurance, then, this is an attractive tax-free way to invest money in the stock market. It’s especially attractive to the young and healthy, since those people have a lower risk of having to tap their HSA to pay medical expenses before their money has had a chance to grow.

HSAs aren’t owned by your employer, or even connected to your insurance, so you can open one and keep it until you retire — they are even listed in the code of federal regulations as retirement accounts. And so, while they were perhaps not originally intended to be a retirement account, that’s what they have morphed into.

Is having an HSA catching on?

As of January, there were 15.5 million people in the US with insurance plans that qualified them to open an HSA, up from 3.2 million in 2006. That said, it’s hard to find data on how many people actually have an HSA. There has certainly been a rapid rise in the number of employers who offer what the industry refers to as “account-based health plans”.

High deductibles pass much of the cost of medical expenses to the individual, and also avoid the 40% excise tax that the Affordable Care Act will introduce to high-value insurance plans. As the latest Towers Watson report on “Reshaping Health Care” puts it:

Account-based health plans (ABHPs) can be an important strategy for reining in costs in advance of the 2018 excise tax and facilitating the shift toward greater accountability from employees and more consumer-like behavior in their purchase of health care.

For people who need to make use of their health insurance often, ABHPs shift expense away from the employer and insurance company, and onto the individual. However, if you are healthy, ABHPs are great: their premiums are lower than other health plans, and if you don’t need to spend a lot on healthcare, your money has a chance to grow in your investment HSA account. Furthermore, HSA proponents argue, making consumers pay for more of their medical expenses will drive prices down as people put more effort into shopping for the lowest price for medical care.

Regulation

But back to our reader’s second question on HSAs: Who are the regulators? The answer depends on what kind of account you have, and who is providing it. If your HSA is in a bank, in cash, then it likely to be FDIC-insured (State Farm, for instance). If you have HSA money in mutual funds, however, those investments are not insured (except in the case of a total bank failure, in which case the SIPC is there for you, probably). Mutual funds are regulated by the SEC.

Non-banks can also be HSA providers, and if your money isn’t in a bank, it won’t be FDIC insured. Take SelectAccount, for example. It’s a subsidiary of the insurance company Blue Cross Blue Shield of Minnesota, which is technically regulated by the Minnesota Department of Commerce. The IRS continues to check that it meets the requirements to be an HSA provider, according to spokesperson Marlo Peterson. It does have deposit accounts — and they are not FDIC insured. It also has investment HSA accounts, where the management of your investment and your mutual fund choices is outsourced to Charles Schwab. In turn, Schwab is regulated by the SEC. Got that?

The Bottom Line

Should you use an HSA as a retirement account? The simple answer is yes: if you already have a high-deductible health plan, then you should, if you have the money, put the maximum amount into an HSA every year.

The second question is what you should do when medical expenses come along. Should you pay them out-of-pocket, using after-tax money, or should you use the funds in your HSA? That’s more of a judgment call, and depends in large part on whether you will miss the money if you spend it out of your pocket, rather than out of the HSA. But given that substantial medical costs in retirement are almost certain for all of us, it makes sense to start saving up for them today in as tax-efficient a manner as possible.

And if you’re now thinking of your HSA as a place to save up for retirement medical costs, rather than for current medical costs, then it’s logical to invest that money in long-term investments, like mutual funds, rather than just keeping it in cash.

Just make sure that you have enough cash lying around to cover any unexpected medical costs you have for the time being. The last thing you want is to be forced to use your HSA to cover near-term medical costs, just when your investments have gone south.

Finally, is your money safe, in an HSA, and do you need to worry about the HSA provider going bust? That one’s harder, and really the only way we’ll find out is if and when it happens. But insofar as you’re keeping your HSA funds in cash, you should certainly make sure that cash is FDIC insured.